5 unit commercial strip, is this a deal?

[Jarred Sleeth]

Hey BP,

I was out yesterday doing some shopping and the owners of the store I was in approached me about selling their other location. I'm a frequent customer and they know I buy real estate which is why they asked. They own the building their other location is at. It's a 5 unit strip center in a good location with two nationally franchised tenants, their store, a hair salon that has been there for a long time, and in the process of signing on the last unit which will be a nail salon. They have owned the building since 1997, and it was on a 99 year ground lease with roughly 65 years remaining. 

I'm posting here in hopes of learning a little bit about this ground lease and what the pros and cons of such an investment would be.  I invest for the long term for cash flow. They are asking 500k which is about 100k/unit, and at that price it didn't seem outrageous or anything. It's not currently on the market, but they are older and are tired of dealing with it. I don't know all of the numbers for income/expenses yet, but I'd like to know if this kind of deal is common and if it would make sense before I sit down with them to get more details.

Does this sound like a deal to you? What would you do? They are motivated and as far as I know I am the only one looking so far.

Thanks!

Jarred

[Daniel Chang]

Originally posted by @Jarred Sleeth:

@Daniel Chang

Thanks for the information. I'm wondering how useful this type of investment would be for me. The acquisition cost seems to be a sunk cost in the end, and the value would actually decrease over time rather than increase. Am I getting this right? For what reason might an investor like myself purchase a deal like this rather than a commercial deal that includes the building and land together?

Thanks!

How useful it would be to you is of course a question only you can answer.  Yes, as the years go on, overall the value would decrease because there's less future potential cash flow.  

Obviously, if everyone had their choice, they would own the property fee simple, meaning the building, land, with full rights of ownership.  Sometimes, it's a matter of capital.  The same building fee simple might be $1.5MM, whereas you can buy the leasehold estate for $500K (just an example).  Sometimes, it's the only option available if it's a property that suits your need as an owner user.

If you would earn an IRR of 20% with a leasehold estate, and a 15% for a similar property fee simple, which one would you rather have? Just remember, that it's not worth 0. If you were able to buy the rights for $50K per year for 65 years for a mere $1000, would you? Of course you would! Even though that $1000 is a "sunk cost" as you would put it. So if you would do $1000, then there is a valuation that makes sense to any investor.

Overall, my general recommendation is if you don't understand the investment, best to stay clear of it.  But it never hurts to get the financials and crunch some numbers.